Posts Tagged ‘LGPS’

David Davison

An Unwelcome Inheritance

Mostly when people are told they have an inheritance it’s good news. A long lost relative or friend has bequeathed some money to you which opens up the opportunity to do all (or at least some) of those expensive items on the bucket list. Unfortunately an inheritance in an Local Government Pension Scheme (LGPS) is usually every bit as much of a surprise and shock, but far from as welcome for the recipient.

Many organisations, having become a participant in the LGPS were blindly unaware that to do so meant that they automatically inherited all the past liabilities for any staff transferring to or continuing with the organisation. Frequently this can mean that charities inherit hundreds of thousands of pounds of liabilities and in some cases many millions.

This anomaly arises because LGPS is unable to identify and allocate past service liabilities between employers, apparently only being able to allocate all of the liabilities to the latest employer. This is undoubtedly incredibly unfair as it means local authorities can deftly transfer the funding risk to an unsuspecting charity. Even where guarantees are provided tend only to protect charities on insolvency and not on voluntary exit or on increases in contributions.

The approach used by the Fund (in most but not all cases) notionally assesses the liabilities as being fully funded at outset so even if the funding level is only 90%, for example, it is assumed to be 100%. However this is far from a perfect solution for a number of reasons:-

    • The value of these liabilities will vary over time. If a further shortfall arises the funding costs for this will have to be picked up the new employer in full even though they did not employ these individuals at the time they accrued the benefits.
    • Where liabilities should have been notionally uprated frequently this has not been actually carried out or the exact terms have been lost ‘in the mists of time”.
    • Even if the benefits were fully funded this would have been on an on-going basis and not on a cessation basis. This means that on an ultimate exit the latest employer would pay a cessation debt on all these previously accrued benefits.
    • Should members benefits be subject to strain costs such as on redundancy or ill health early retirement these additional costs would have to be met in full by the latest employer.

These issues can come in to sharp focus where the latest employer has been admitted as part of an out-sourcing exercise. Procurers can inherit past service liabilities which dwarf any future service benefit which can be accrued over the term of the contract and become responsible for variations in the value of these liabilities over the contract duration and at the contract end date. Attempting to deal with these issues, usually very imperfectly, is achieved via contract negotiation and terms which again adds unnecessary complexity, inconsistency and frustration. A worked example showing the issues is available here.

Funds should really be dealing with this issue properly by segregating liabilities, as is the case in most other large multi-employer schemes. The costs related to past service liabilities would be fairly retained with the employer who accrued them with future service only being the responsibility of the new employer.

Frustratingly many Funds continue to deny the issue of inherited liabilities. It is totally inequitable to expect a small charity to pick up a cessation liability for benefits they previously inherited from a public sector body on an on-going basis, or even in many cases a funding basis well below this. I’m surprised more fuss hasn’t been made of this!!

Some Funds however have sensibly identified this and looked to deal with it fairly and I can only hope that all others will follow. Indeed these liabilities should just be re-allocated to public sector ownership, which is totally possible, and would mean that the Fund has them guaranteed with no cessation debt requiring to be paid. I can only think the reason for not doing this is the LA’s know they’ve dodged these liabilities and don’t want them back!!

The recent ICAS report made recommendations how this issue could and should be addressed. I would recommend that any charity that have witnessed significant contribution increases or have been provided with a cessation debt consider this issue and have it properly investigated as it could have a material impact and it seems an issue which when outlined would not be easy for funds to reject.

 

David Davison

A Landmark Judgement

The objective of bringing LGPS funds more in line with all other UK pension schemes and forcing them to invest in the best interests of members came a little closer after the government suffered a major defeat in the High Court at the end of June.

The government had issued guidance in September 2016 requiring LGPS funds to have environmental, social and governance (ESG) policies but added a requirement that funds could not “pursue policies that are contrary to UK foreign policy and UK defence policy”.

The Palestine Solidarity Campaign (PSC) launched a bid in the courts to overturn the regulations via a judicial review. It contended that the government had acted outside its powers and it was “lacking in certainty”. It also cited Article 18.4 of the EU’s directive on the Activities and Supervision of Institutions for Occupational Pension Provision (IORP) that states “member states shall not subject the investment decisions of an institution…….to any kind of prior approval or systematic notification requirements”.

Judge Sir Ross Cranston only agreed with the first argument citing that he couldn’t see “how the secretary of state had acted for a pensions’ purpose”. He therefore granted the judicial review.

A spokesman for DCLG said that the government would consider whether to appeal.

While the judgement was broadly welcomed it may not be quite the end of the issue as trade unions encourage the government to implement EU IORP directive into LGPS.

The judgement does however mean that Funds will have more freedom to take positions on ethical investment focussed wholly on the best interests of scheme members which must be a benefit.

David Davison

In April this year the DWP launched the snappily titled public consultation ‘The draft Occupational Pension Schemes (Employer Debt) (Amendment) Regulations 2017’. The consultation, which closed on the 18th May, was looking to make suggestions to deal with the perennial issue of Section 75 debts. A Section 75 debt triggers when an employer ceases to have active employees in a multi-employer scheme while other employers still do.

All very interesting (or not) but what does this have to do with LGPS you may ask, especially given neither the Section 75 legislation nor the DWP consultation actually cover LGPS? However while Section 75 legislation may not specifically apply to LGPS the principles on exit / cessation and the issues the consultation is looking to address are pretty much the same. In fact some of the specifics of LGPS actually make the options for employers even more restrictive than in other ME schemes.

The consistent issue is that neither multi-employer defined benefit schemes (MEDBS) or LGPS have a mechanism to allow participants to cease building up benefits for all members without automatically trggering a debt at that point. This is a mechanism available in standalone and segmented multi-employer schemes allowing employers and trustees to more effectively manage risk. The lack of this option encourages participants to continue to build up additional benefits for staff way beyond the point where they are affordable, placing their very existence at risk, reducing the covenant of member benefits and risking placing an additional burden on other organisations who participate in the scheme. Legislation as it sits at the moment not only limits an employer’s ability to manage this risk but also ties the hands of those running the pension scheme.

Many employers are now facing a cliff edge as their membership numbers fall. Many recognised the risk and associated costs of DB provision and closed their schemes to new entrants. This just makes a movement towards ultimate cessation inevitable as eventually they will run out of active members. Research recently carried out by the Scottish Government in relation to Scottish LGPS has highlighted this wall of risk and Funds throughout the rest of the UK will be no different.

A way that many private sector MEDBS have looked to deal with the issue is either to close to future accrual for all employers simultaneously or to add a defined contribution scheme under the same trust as the defined benefit scheme thereby allowing employers to have active participation but to have stopped accruing further DB liabilities. Unfortunately neither of these solutions is open to LGPS employers.

In one of my previous Bulletins ‘An Alternative Approach’ I highlighted the potential impact of the timing of this debt trigger and how this was effectively a one-sided equation stacked in favour of the Fund and unfortunately an equation that many admitted bodies are unaware of until it’s too late.

The DWP Consultation sought comments on a potential solution called a deferred debt arrangement (‘DDA’) which would allow employers to cease further DB benefit accrual and continue to fund the scheme without triggering the S75 debt. Employers would retain all the same obligations towards the debt and scheme to protect members and the Trustees but it would permit a more practical and orderly exit from DB accrual.

There does seem to be consensus at this stage that something does need to be done, though some variation in the mechanism to achieve it. I can only hope that we get some practical and workable proposals out of the consultation and that it is more widely applied covering LGPS. Action needs to be taken now but given our current political environment and the Governmental focus on Brexit it would be a brave man to predict we will see anything substantive in terms of legislation in the short term, let alone seeing it extended to LGPS, even though in my view it quite clearly should be.

David Davison

In an earlier bulletin, I looked at why the current basis of cessation for admitted bodies in LGPS was causing problems and how the inconsistency of approaches taken by Funds meant that organisations struggled to understand their obligations and what steps were open to them to address the issues they face.  You can read the bulletin entitled ‘An alternative approach to cessation’ here.

In some work undertaken over the last few months I’ve identified that some Funding Strategy Statements (‘FSS’) revised over the last couple of years seem to suggest that some Funds are taking tentative steps to try to address the situation. Read more »

David Davison

I’m often asked to explain why contractors have finished up with a substantial bill payable to an LGPS at the end of an out-sourced contract. I’ve therefore compiled this very simplistic worked example to highlight the issues contractors face. The figures are for representative purposes only and are not intended to be either detailed or LGPS liability specific. Read more »

David Davison

We are delighted at Spence to be able to support a further two publications launched over the last week.

  • The 4th Edition of Charity Finance Group (‘CFG’) “Navigating the Charity Pensions Maze” was published in London on Thursday 23rd March. Spence were pleased to sponsor this invaluable publication and our Director and Head of our Charities Practice, David Davison, provided technical input on the Guide content. The Guide contains an excellent section on “Navigating the Local Government Scheme” compiled by leading legal firm Charles Russell Speechlys. This covers the benefits and risks of membership and provides a list of helpful questions charities should be asking about their participation. The CFG accompanying blog can be found here.
  • Leading representative body the Pension & Long Term Savings Association (‘PLSA’), formerly the NAPF, have launched the third of their guides covering Best Practice for Employers in LGPS with David Davison again providing technical input on the content. This was launched on the 28th March and a link to the launch information can be found here.

We believe these documents, and those published previously, will provide an excellent resource for charity trustees and senior personnel to assist them in dealing with the issues associated with LGPS membership.

David Davison

An Amicable Divorce

The question I’m asked about most often is about the cost of exiting a LGPS, as for most charities the costs can come as a bit of a surprise. One organisation I worked with recently had a small surplus at their last actuarial review and in their accounts, but when a couple of their staff left unexpectedly they were immediately hit with a bill from the fund in excess of £500,000, pretty much wiping out all their assets and placing them on the brink of insolvency. So what do you need to know?

Should you run out of active members in your LGPS fund (and not be in a position to add any new ones, for example if you have a closed agreement or a local authority contract has come to an end) under the LGPS Regulations the fund must commission the Fund Actuary to complete a cessation valuation. Whilst the Regulations do not prescribe how this calculation should be carried out, the actuaries undertaking the calculation will use very prudent ‘least risk’ assumptions based on gilt yields. This will result in liabilities being much higher than is the case on either a funding or accounting measure. Often this is the first point that an admitted body may be aware of this liability, as unfortunately numerous funds still do not provide organisations with an annual estimate of the potential cessation debt.

The conservative approach taken reflects that once an organisation exits an LGPS, the fund cannot pursue them for any extra money if the cost of providing members’ benefits is higher than expected. The fund therefore wants to make sure that there is a minimal risk that other employers in the fund would be responsible for paying for any of these exiting liabilities. As such the approach is a protection for all. However, what has been called in to question more recently is whether the basis adopted is reasonable, and indeed suitable in all circumstances. What is clear however, is that there is a great reluctance on the part of the funds to change, not surprisingly.

Whilst the approach to calculating a cessation debt across Funds, and across the various fund actuaries, tends to be consistent, the circumstances in which it applies can vary significantly. For example, some funds offer public sector out-sourcers ‘pass through’ protection, which means that any cessation debt is calculated on the much lower on-going funding basis. Other funds recognise where the last employer has inherited significant liabilities from a public sector body, and will account for these by ensuring that the public sector body picks up their fair share. Unfortunately, though the vast majority of funds do not.

Some funds are prepared to negotiate around the cessation amount payable, subject to affordability and the term of any repayment. However, in most circumstances these negotiations need to be conducted in advance of any formal debt trigger / calculation.

Admitted bodies therefore need to be aware of their situation and look to plan for it, as far in advance as possible, as allowing a cessation event to just happen could have catastrophic implications for the charity.

In my next bulletin I’ll consider why change should be considered.

David Davison

Many charities participating in local government pension schemes (‘LGPS’) have been increasingly frustrated by the lack of recognition of the issues they face by the schemes they participate in and, indeed, from Department of Communities and Local Government (‘DCLG’) who oversee them. The issues are not new but there remains an element of denial and finger pointing, and it’s very easy to see how charities could be understandably frustrated.

I often experience a feeling amongst charitable admitted bodies that Councils and LGPS encouraged them to join Funds, without ensuring independent advice was sought or providing any risk warnings about the step they were taking, and have now just abandoned them to their fate. Whilst, to a great extent, the problem has been capped over recent years as admission to Funds has become much more rigorous, this unfortunately does nothing for all those employers admitted before that stable door was closed.

For those employers, LGPS have sat on their hands allowing organisations to continue to accrue liabilities even when they clearly couldn’t afford to do so, and without providing the flexibility to address the issue. Many charities I’m aware of have approached LGPS over many years looking to stop accrual, and arrange a payment plan and were just provided with pay up or keep participating as options. Now, as funding positions have deteriorated and funding costs have increased these same schemes are pointing fingers at these same trapped charities for their inability to be able to continue to participate.

For many charities there is also a growing recognition that Councils have adeptly transferred historic past service liabilities in £millions to them, due to LGPS inability to segregate service between employers and without making employers aware of the impact. This has been hugely expensive for charities and DCLG and LGPS continue to try to ignore this issue and sweep it under the carpet. Indeed, LGPS continue to do this with unsuspecting Academies being a prime example.

A limited number of Funds and Local Authorities have sought to deal with the issues however, the response has been at best patchy and has lacked any level of standardised practice. Indeed these ore enlightened approaches attract a “nothing to do with me” response when raised with pension managers from Funds not employing them and for many admitted bodies they are completely unaware of the alternative options explored and implemented elsewhere. A lack of consistency of approach also means that each exercise needs to be looked at on an individual basis, adding complexity and professional adviser costs when helping charities through the maze.

The Shadow Scheme Advisory Board (SSAB), which was established to encourage best practice, increase transparency and coordinate technical and standards issues for LGPS as well as providing recommendations to Government for future regulation commissioned a report from PWC as part of its deficit management project kicked off in summer 2014.

The report was published in July 2015 and the key recommendations which will be of specific interest for admitted bodies are:

  • More flexibility on when exit debts are triggered. The proposals suggest that debts would not be automatically triggered by the exit of the last member. The paper recognises that some minor changes to regulation will be required.
  • Establishing a maximum level of prudence when calculating exit payments. Currently Schemes tend to use a gilts basis to calculate the exit cost despite schemes not investing assets in this way. This effectively means that employers paying a cessation debt are cross funding other employers who remain. This is recognised as inequitable and is also a discouraging factor for charities wishing to look at an exit. This proposal would effectively reduce cessation debts for those looking to exit the Scheme, for many to a point which may be affordable.
  • Flexible exit arrangements. These could include continuing to pay contributions on an on-going basis for a prescribed period and for employers to pay their cessation debts over a much longer period. This would be extremely welcome flexibility for many small employers and is a more consistent approach with that adopted in the private sector.
  • Employer exit on weaker terms. It is recognised that, in some circumstances, it could be in the interests of the Fund, the remaining employers and the admitted body to allow them to exit on weaker terms and small charities are cited specifically as an example.

These items certainly reflect much of the commentary supplied by charity representative bodies, charity advisers and charities themselves although at this stage they haven’t fully addressed issues around the transition of prior local government liabilities to charities but it is hugely helpful to charities’ positions and it has been a welcome addition to the debate, especially given that it comes from such a reputable source.

Unfortunately however, it has disappeared in to something of a black hole, possibly overtaken by other more pressing global events. The proposals however need to be addressed by the SSAB and implemented by Government and LGPS as quickly as possible. The issues faced have been created by local government, LGPS and the admitted bodies and there needs to be a commitment to co-operatively finding solutions, and a desire to do it soon. Charities need to be vocal with their Funds and local authorities about the issues they face and get them to look to address them positively. Charities should also be working collectively and in conjunction with their representative bodies to make sure their voices are heard.

David Davison

Playing the waiting game

In our fast paced society no one really likes waiting for anything, however for those financial directors of charities participating in local government pension schemes in England & Wales I’m sure they wouldn’t mind waiting a bit longer for their valuation results given everything else going on around them.

Read more »

David Davison

Taking the Strain

When faced with cost constraints, considering a reduction in staff is an obvious early consideration. However, for those employers with staff in LGPS great care needs to be taken as ‘strain costs’ imposed by the Fund could result in very significant payments, often well in excess of any salary savings made. So what do you need to look out for? Read more »

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